Boot, A.

Schoenmaker, D.

English

Climate change is a relevant risk factor for the banking sector, but the European Commission's plan to lower capital requirements for greener investments is irresponsible in encouraging banks to forego proper risk management

International Migration, Integration and Social Cohesion online publications

UvA-DARE is a service provided by the library of the University of Amsterdam (https://dare.uva.nl)UvA-DARE (Digital Academic Repository)Climate change adds to risk for banks, but EU lending proposals will do moreharm than goodBoot, A.; Schoenmaker, D.Publication date2018Document VersionFinal published versionLink to publicationCitation for published version (APA):Boot, A. (Author), & Schoenmaker, D. (Author). (2018). Climate change adds to risk forbanks, but EU lending proposals will do more harm than good. Web publication or website,Brueghel. http://bruegel.org/2018/01/climate-change-adds-to-risk-for-banks-but-eu-lending-proposals-will-do-more-harm-than-good/General rightsIt is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s)and/or copyright holder(s), other than for strictly personal, individual use, unless the work is under an opencontent license (like Creative Commons).Disclaimer/Complaints regulationsIf you believe that digital publication of certain material infringes any of your rights or (privacy) interests, pleaselet the Library know, stating your reasons. In case of a legitimate complaint, the Library will make the materialinaccessible and/or remove it from the website. Please Ask the Library: https://uba.uva.nl/en/contact, or a letterto: Library of the University of Amsterdam, Secretariat, Singel 425, 1012 WP Amsterdam, The Netherlands. Youwill be contacted as soon as possible.Download date:10 Mar 2023Climate change adds to risk for banks, but EU lending proposals will do more harm than good | Bruegelhttp://bruegel.org/2018/01/climate-change-adds-to-risk-for-banks-but-eu-lending-proposals-will-do-more-harm-than-good/[9-1-2019 10:54:49] BLOG POSTClimate change adds to risk for banks, but EUlending proposals will do more harm than goodClimate change is a relevant risk factor for the banking sector, but the EuropeanCommission's plan to lower capital requirements for greener investments isirresponsible in encouraging banks to forego proper risk management.BY: ARNOUD BOOT AND DIRK SCHOENMAKER  DATE: JANUARY 16, 2018TOPIC: ENERGY & CLIMATERunaway climate change is the ultimate systemic risk for banks– and yes, lending to coal companies is a risk as well, and needsto be discouraged. Nevertheless it was shocking to hear, at therecent One Planet Summit in Paris, European CommissionerValdis Dombrovskis’ sudden enthusiasm for letting banksdispense with their usual prudence in risk management when‘good’ green investments are involved. It is a bad idea to grantbanks extra-low levels of capital if something is ‘green’; realisingthe extra risk of ‘brown’ does not make ‘green’ extra-safe.Commissioner Dombrovskis should be stopped. HisPUBLICATIONS  BLOG  EVENTS  MORE  Climate change adds to risk for banks, but EU lending proposals will do more harm than good | Bruegelhttp://bruegel.org/2018/01/climate-change-adds-to-risk-for-banks-but-eu-lending-proposals-will-do-more-harm-than-good/[9-1-2019 10:54:49]announcement that he will “look positively” at a “green supportfactor” for bank lending is irresponsible and wrong. Endorsing“lowering capital requirements for certain climate-friendlyinvestments, such as energy-efficient mortgages or electric cars”is asking banks to turn a blind eye on proper risk management,as we don’t know which green technologies will win. It isunacceptable.The Commissioner is correct that climate risks are material forbanks and need to be taken into account in setting capitalrequirements. Currently this is not the case – an increasinglyimportant risk factor, neglected at our peril. According to theFSB Task Force on Climate-Related Financial Disclosures,climate change is “one of the most significant, and perhaps mostmisunderstood risks” that “could have significant, near-termfinancial implications.”Most evidence points towards higher risk not only due toclimate change but also the fight against it. There is the so-called ‘physical risk’ of a changing climate – such as thewildfires, hurricanes and droughts that damage or destroyassets – and the ‘transition risk’; new innovations that limitclimate change can turn existing assets into stranded assets.Instead of the ‘green supporting factor’ that the EuropeanBanking Federation lobbies for, a much stronger case can bemade for a ‘brown penalising factor’ for fossil-fuel-intensive and-dependent assets. Not only does this give lenders the capacityto withstand losses when the energy transition accelerates (as itmust if we are to achieve the stated global goal of limitingclimate change to well below two degrees), a brown penalisingfactor will also discourage further investments that contributeto climate change. Thus the systemic risk of climate changeClimate change adds to risk for banks, but EU lending proposals will do more harm than good | Bruegelhttp://bruegel.org/2018/01/climate-change-adds-to-risk-for-banks-but-eu-lending-proposals-will-do-more-harm-than-good/[9-1-2019 10:54:49]itself would be reduced.Given the thin rationale for lower capital requirements, themeasure may well prove to be ineffective as well. When banksrecognise that the actual risk is not lower they may stick to theirown models and hence will still demand economic capitalaccording to their own expectations, not those of the regulators.At least, this is how banks should function. However, they onlywill when they expect that they themselves will bear the burdenof overly risky lending practices. Unfortunately, the Europeanbanking sector is not there yet, despite the improvements madeover the last decade. Capital buffers are still too low, banks toointertwined with each other and their sovereign. If things gowrong with enough banks at the same time, governments willmost probably step in again.In its final report, due in January, the EU High Level ExpertGroup on Sustainable Finance should stick to the position ittook this summer – that is, that higher capital charges forunsustainable assets “yield a constellation in which risk andpolicy considerations go in the same direction”.Preferably this is done through the first pillar of the capitalregulation framework that sets minimum capital requirements.Climate exposures – proxied by the carbon intensity of assets –should be translated into credit risk. This cannot be done usingmodels that are based on historical data, as the energytransition is an unprecedented development. Rather, scenariostudies should be used to quantify the impact of transition. Thisinnovation in risk assessment breaks with convention; such abreak is necessary, though, as it is still better to be roughly rightthan exactly wrong.Climate change adds to risk for banks, but EU lending proposals will do more harm than good | Bruegelhttp://bruegel.org/2018/01/climate-change-adds-to-risk-for-banks-but-eu-lending-proposals-will-do-more-harm-than-good/[9-1-2019 10:54:49]  + View commentsCombatting climate change, while indeed a laudable endeavour,is only a legitimate element of capital regulation if it addressesrisk or financial stability. Using other objectives for settingcapital requirements will at best prove ineffective; at worst, willit undermine financial stability and give sustainable finance abad standing. In response to Dombrovskis’ announcement,ratings agency Moody’s has already signalled this may lead tolower credit ratings of EU banks.Banks need more capital, not less. Climate change adds to thegravity of this issue, it poses new and additional risks for banksthat are already insufficiently capitalised. Green support factorstherefore should not be the priority of the EuropeanCommissioner responsible for financial stability.Republishing and referencingBruegel considers itself a public good and takes no institutional standpoint.Anyone is free to republish and/or quote this post without prior consent.Please provide a full reference, clearly stating Bruegel and the relevantauthor as the source, and include a prominent hyperlink to the original post.    BANKS  CLIMATE CHANGE  SUSTAINABLE FINANCE

Climate change adds to risk for banks, but EU lending proposals will do more harm than good

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Climate change adds to risk for banks, but EU lending proposals will do more harm than good

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